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London’s Economy Today – February 2022 editorial

Rising inflation places pressure on living costs

Data from the Office for National Statistics (ONS) showed that Consumer Price Index (CPI) inflation reached 5.5% year-on-year in January (Figure 1), ticking up 0.1 percentage points from the December reading and setting a new 30-year high (since March 1992). The fastest monthly price growth came from alcohol and tobacco and food. The largest contributions to annual growth came once again from vehicle fuels (0.7 percentage points (ppts)), secondhand cars (0.7ppts), gas (0.4ppts) and electricity (0.4ppts). These areas reflect the impact of rising global energy prices and supply chain challenges, but price pressures are increasingly widespread as costs trickle through the economy. While goods prices are rising most rapidly, growing 7.2% year-on-year in January, services prices are also seeing some of the fastest increases in several years, rising at an annual pace of 3.2%.

Figure 1:

At a regional level, the National Institute of Economic and Social Research (NIESR) estimates a set of regional trimmed-mean inflation series, cutting out the most volatile prices to identify underlying inflation. This gauge was running at 5.2% year-on-year for London in January, compared to 4.3% for the UK overall. This placed London as one of the two UK regions facing the highest rate of underlying inflation, just behind the West Midlands. We have recently set out our view on the impact of the rising cost of living on Londoners in a published report and the latest figures reinforce the concerns we expressed there.

Polling in January by YouGov on behalf of the GLA backed up this picture of key prices rising for Londoners, with 79% of respondents reporting an increase in their cost of living over the last six months. Around 13% reported that they were struggling to make ends meet and among Londoners with gross household incomes of less than £20,000, the share more than doubles to 27%. Londoners were most likely to report larger increases in their food and energy bills, both of which are spending categories that lower-income groups devote a relatively large share of household spending.

Current high inflation rates after rising further in coming months are expected to dissipate over time, but this looks increasingly likely to be at a gradual pace. Key supply chain indicators like shipping costs, business sentiment around backlogs and supplier delays have eased, though they remain at elevated levels. However, the Russia-Ukraine crisis is contributing to supply concerns and rising oil prices, while market signals point to fears that global energy costs will take some time to ease.

Bank of England raises interest rates again

In response to rising inflation, the Bank of England raised its policy interest rate by 25 basis points at its meeting on 3 February, leaving the Bank Rate at 0.5%. Coming after the December increase to 0.25%, this was the Bank’s first back-to-back pair of rate hikes since 2004 as policymakers sought to bring inflation back under control after its recent increase.

The Monetary Policy Committee has adopted an increasingly hawkish tone on inflation and after December’s meeting saw a single Committee member dissent in favour of keeping rates on hold; February saw four members dissent in favour of hiking by 50 basis points rather than 25. With fears easing over the impact of the Omicron variant of COVID-19 on the UK economy and inflation continuing to rise, the Bank emphasised growing concerns around wage growth. Policymakers emphasised evidence of an increasingly tight labour market, with vacancies spiking while unemployment eases, potentially prompting wage increases ahead of productivity gains and stoking more persistent high inflation.

Despite projections that underlying wage growth would pick up to around 5% across the course of 2022 (from a current pace of around 4.0-4.5%), the Bank still forecast that these gains would be more than eroded by high inflation. A peak inflation rate of over 7% in April and price gains of more than 5% year-on-year out to early 2023, combined with tax and benefit changes, meant that the Bank expected real post-tax labour income to drop by 2% in 2022. This constitutes one of the tightest squeezes on household incomes on record and certainly for more than ten years. As a result, the Bank projects demand to slow and unemployment to rise from mid-2022, leaving some spare capacity in the economy by 2023. Despite this gloomy outlook, the Bank maintained a tight focus on its mandate to bring inflation to the 2% target over the medium term. Policymakers observed that while the UK faces a cost shock that will lower aggregate purchasing power, the Bank does not believe it can change this shift but can only try to ensure moderate inflation in the medium term.

While academic literature suggests that London’s relatively lower share of manufacturing and other goods sectors may make it more resilient to rising interest rates than some other parts of the UK, the capital’s high house prices may create some offsetting pressure (Furceri & Mazzola, 2019). Overall, the Bank’s projections of high inflation, rising unemployment and weak real incomes make for sobering reading for London, the UK region estimated to have the highest price levels in normal times and the slowest unemployment recovery from the pandemic.

All Covid restrictions to end in England

The Government has announced that all remaining COVID-19 restrictions and self-isolation support payments in England will end on 24 February, a month earlier than previously planned, while free testing will end on 1 April. This removes with immediate effect the legal requirement to isolate if you are infected with COVID-19, with all COVID-19 related regulations planned to end on 1 April.

Despite the end of legal restrictions, the seven day average of people testing positive for infections in the capital stood at over 5,500 on 12 February. Still, infections are down in London from their recent peak of over 29,000 towards the end of December 2021 and data shows that the economy continues to recover from the impact of the Omicron variant. Thus, consumer-facing indicators for London continue to rise although still remain below pre-pandemic levels (Figure 2).

Figure 2: Individual personal activities in London, March 2020 – February 2022, relative to pre-COVID-19 baseline

Source: Grocery and retail metrics from Google Mobility, social venues (bars, event spaces etc) from Purple public Wifi and restaurant bookings from OpenTable

Although consumer-facing sectors in the capital may be recovering from their lockdown lows, the continued impact of working from home, along with low international tourist numbers, may be dampening the spring back especially in the Central Activities Zone. Thus, looking at the ongoing prevalence of working from home in the UK the ONS has found that for London single-site businesses in the services sector had 51% of their workforce estimated to be working from home or using a hybrid working model in mid-January 2022. This was the highest percentage for the sector of any UK nation or region, with the UK average standing at 33%. While, for all industries the figure stood at 50% in London compared to 29% for the UK as a whole.

Payrolled employment in London above pre-pandemic levels

As noted the recovery from the pandemic continues. Provisional data from HMRC’s Pay As You Earn (PAYE) RTI dataset showed an increase in the number of payrolled employees living in London in January 2022 of around 22,600 or 0.5% on the previous month, with it further showing an increase of 252,000 or 6.4% on the previous year. The number of payrolled employees in London was also up, by 16,100 or 0.4%, on pre-pandemic (February 2020) levels although this is a smaller percentage increase than for the UK as a whole (1.5%). There is also wide variation in the recovery in payrolled employees by sector in the capital (Figure 3). Public administration & defence saw the highest percentage growth in payrolled employees at 9.8% between February 2020 and January 2022, followed by Administration (6.5%) and Health and social work (6.0%). Hospitality saw the largest decrease of 10.1%, followed by Other services (down by 5.3%) and Arts, entertainment & recreation (down by 5.1%)

Figure 3:

London’s unemployment rate also continued to fall from its pandemic peak, but was still higher than the UK average in the three months to December 2021. The capital’s unemployment rate was estimated at 5.2%, down 0.5ppts on the quarter and down 2.1ppts from a year earlier. The UK average was 4.1%.

The claimant count, the number of people claiming Jobseeker’s Allowance plus people claiming Universal Credit who are required to seek work, is a timelier source of data, although some new claimants will be in part-time work. Still this rate has also declined from a peak of 8.4% in March 2021 to 5.6% in January 2022 in London. However, the rate varies across the capital with Haringey having the highest claimant count rate at 8.1%, followed by Newham (7.8%) and Brent (7.7%). Richmond upon Thames (2.9%), Kingston upon Thames (3.1%) and Sutton (3.3%) had the lowest rates at the beginning of the year.

UK GDP grows strongly in 2021

The ONS published estimates of UK GDP growth in the final quarter of 2021 this month. In this they found that UK output grew by 1.0% in Q4 2021. This follows a downwardly revised growth rate of 1.0% in Q3 2021. Over the whole of 2021 GDP grew by 7.5%, following a fall of 9.4% in 2020. GDP measured by the quarterly measure remains 0.4% below its pre-pandemic levels in Q4 2019, although as measured by the monthly measure GDP is now at the same level it was in February 2020 (prior to the pandemic) despite having fallen by 0.2% in December 2021.

Of the major sectors of the economy, the services sector grew by 1.2% in Q4 2021 and is now 0.5% above its pre-pandemic levels, the construction sector grew by 1.0%, but the production sector declined by 0.4%. However, although the service sector as a whole grew at the end of last year the ONS notes that “the Accommodation and food services, and Wholesale and retail trade industries were both adversely impacted by the emergence of the Omicron variant towards the end of the quarter”, with both seeing output declining by around 0.1%.

London output continued to grow in the first half of 2021

The ONS published their quarterly estimate of regional GDP this month, with London’s economy rising at a faster-than-expected 4.5% across Q2 2021. This positive reading comes after London also saw nearly no contraction in Q1 2021 despite the third lockdown, and puts London to within less than 1% of its pre-pandemic level of output. As a result, while London’s Q2 growth was the third-lowest of any UK region, its recovery from the pandemic in level terms is among the most advanced, with only Wales significantly ahead.

Within the sectors of London, Accommodation and Food services grew by far the fastest, but its advance of just under 40% was still not enough to recover the lost output from two successive contractions in the previous quarters. Output in the hospitality sector remains almost 40% below pre-pandemic levels. Construction and production sectors rose faster than services sectors on average, though Construction still has the weakest recovery overall. Within the services sectors, Wholesale and Retail has staged the strongest recovery so far, with output reaching nearly 12% above pre-pandemic levels, though Information and Communication is not far behind at 11% above its end-2019 output level.

Looking ahead, we expect growth to have decelerated across the second half of 2021, though this month’s figures suggest that London was closer than previously estimated to recovering its pre-pandemic levels of output. Plan B restrictions and Omicron variant infections will likely have brought the capital’s economy to its slowest growth since the third lockdown at the end of the year, but we do not expect the recovery to go into reverse with many sectors avoiding significant damage. Moving into 2022, high inflation and pressure on household incomes are likely to squeeze demand more than we previously expected, with consumer-facing sectors the first to slow before the wider economy moderates towards a more normal pace of growth. We will be releasing an update to our macroeconomic forecast and scenarios at the end of this month. GLA Economics will continue to monitor these issues over the coming months in our analysis and publications, which can be found on our publications page and on the London Datastore.